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What Is A Bad Operating Agreement?

Did you know that most litigation is due to partnership disputes involving a bad operating agreement? A business operating agreement is to your LLC what a prenuptial agreement is to your marriage. If your company doesn't have an operating agreement for LLC — you have created an enormous liability.

The operating agreement LLC ensures that everything goes smoothly, and everyone will live "happily ever after." Hence, the operating agreement needs to be put together correctly, ideally by a litigation lawyer, just in case things go south.

What Is An Operating Agreement?

No one wants to assume conflicts are going to happen, but the truth is protecting yourself, and your company is just smart business. A business operating agreement, overseen by a litigation lawyer, creates ground rules, not only for managing the company but also for resolving any unforeseen, future disputes.

Many businesses tend to gloss over the operating agreement LLC and toss something together, assuming it isn't essential to have specific key operating procedures laid out explicitly. A limited liability company operating agreement is vital, so you should read over it carefully, alongside the guidance of a litigation lawyer or litigation attorney — to fully ensure that it reflects the plan for your business.

What Makes An Operating Agreement Bad Or Ineffectual?

An ineffectual Operating Agreement is either a free template found on the Internet, an old document that hasn't had any updates or revisions for 10 years or more.

What makes your Operating Agreement void, and your company liable for lawsuits? Well, is your agreement not customized for your business, your tax status, or your personal circumstances. That's a problem.

Conduct An Audit — Hire A Litigation Lawyer For Expertise

We recommend, as litigation lawyers, conducting an "audit" on your LLC's current Operating Agreement. You can use the tips below to determine whether you have a bad operating agreement or not:

  1. Death And Tax Status

An inadequate Operating Agreement glosses over tax issues. It doesn't address essential situations, such as when a business partner dies or becomes incapable of performing his or her duties. It also does not address the tax code's latest changes.

The LLC operating agreement is vital in organizing your tax status. For example, if you are the sole proprietor, you can be taxed as an individual or as a corporation. Or if there is more than one business member, you can be taxed as a partnership or a corporation. In sum, the provisions within your operating agreement must match the tax designation filings made.

Does your Operating Agreement have language addressing ALL of the below? (If not, you have a bad agreement):

  • If a partner dies or faces serious injury?
  • Preventing or allowing voluntary withdrawal?
  • What powers are reserved for the business members (or managers, etc.)?
  • If relevant to your business, any possible owner restrictions such as non-compete, non-solicitation, or language addressing whether an owner is expected to work full-time?
  • And, what to do when the owners are deadlocked?
  1. Members and Partners

Another vital designation is who is an employee and who is a member. In particular, this is even a vague area of the law, since it's pretty standard for these roles to overlap. Many business members designate themselves as employees. However, for tax purposes, you can only be one or the other. We can help make sure your operating agreement is clear and explicit — learn about how Nick Heimlich Law can help with your business formation here.

  • Is your company taxed as a partnership?
  • Look for "Partnership Representative." If missing, you have a bad agreement.
  • Look for "Tax Partner" or "Tax Matters Partner." If these are listed, you have an outdated Operating Agreement, and it’s a bad agreement.
  1. Bankruptcy Issues

Of course, no one plans on going bankrupt, but it's always a possibility and essential to prepare for. So, it would be best if you were sure that your operating agreement is an executory contract. This means it includes contractual, explicitly mentioned obligations that have a material business purpose and, more importantly, can be applied to any member or trustee who takes over a member's interest or a creditor.

Updating Your Operating Agreement

Many people create thorough and robust operating agreements. But then they forget to update them when there are changes to tax status, members, or buy-sell agreements. Be aware and hire a litigation lawyer for expertise. This can lead to a lot of disputes that require legal action. It is essential to update your operating agreement.

About Nick Heimlich Law — A San Jose Business Litigation Lawyer

Don't make yourself vulnerable — hire a litigation lawyer. Get a reliable and substantial operating agreement in place today. Even if it's your sole business owner, and you have a single-member LLC operating agreement. Make sure your operating agreement protects you from creditors, bankruptcy, and taxes.

Nick Heimlich Law helps you get an operating agreement for your business quickly and affordably. We start by asking you only a few questions about your business. From there, we create and review your operating agreement for consistency and completeness, and send it to you with instructions on how to properly sign it. Contact us here